Credit schemes for microenterprises: Motivation, design and viability

• Main Author: Benjamin, McDonald Phillip
• Format: Dissertation
• Language: English
• Published: ProQuest Dissertations & Theses 01-01-1994
• Subjects: Banking; Economic theory; Finance
• ISBN: 9798208359129

Although employment in microenterprises is expanding rapidly in developing countries, microentrepreneurs have limited access to formal savings, credit and insurance services. Since they cannot insure fully against idiosyncratic risk or obtain sufficient resources for investments with high net economic benefits to society, Pareto efficiency does not hold. Even constrained Pareto efficiency is unlikely, given the externalities, endogenous information and incomplete markets that characterise developing economies' financial markets. We therefore motivate non-market interventions on efficiency grounds. We analyse a key aspect of the design of microlending operations with a moral hazard model that considers under what conditions group lending is superior to loans to individuals. If banks can monitor borrowers' investments intensively, group lending is inadvisable as it passes on risk to borrowers that the bank can readily absorb. Under asymmetric information, we find that even if agents pursue investments with uncorrelated returns, provide no assistance to each other and borrow in groups that do not reduce transaction costs, group lending schemes involving interlinked contracts are still justified when there is some cooperation between agents. Without cooperative behaviour, group lending fails to outperform individual loans. Thus lenders should adopt practices that foster cooperation, e.g., let borrowers form the groups, keep the same group together over time, and offer short term, frequently repeated loans. We consider whether banking for the poor can be viable by adapting and applying Yaron's subsidy dependence index (SDI) to 13 microlenders. We find that ADEMI's operations in the Dominican Republic confirm that banking for the poor can be profitable. Furthermore, most other microlenders' reliance on subsidies has fallen steadily, although econometric analysis reveals that this is mainly because their use of subsidies has increased less rapidly than their scale of operations. Nonetheless, some of the sample microlenders have excellent prospects for viability. Our theoretical and empirical findings support our thesis, namely that there are efficiency considerations that justify banking operations targeted at the poor and that properly designed banking schemes for the poor can be economically viable.